Being a behemoth: how Microsoft (and 9 others) make their billions

Can business success and technology innovation go hand in hand? We take a …

It has become a bit of a cliché: really innovative technology comes from garage-level startups. Once a company gets too large, it focuses its energy on keeping its existing customers happy, and loses its edge. But, for the most part, the technology we rely on for getting things done—providing the hardware and networking infrastructure, for example—comes from mature, profitable companies. So, we thought it might be interesting to take a step back and look at what tech companies are among the most successful at marketing products and services that are widely put to use.

Of course, any measure of "success" is inviting argument. Should it be profits, units sold, recent growth? We settled on two measures. The first is the market capitalization, which provides some sense of how the financial community views both a company's current fiscal strength and its potential for future growth. To provide some sense of how much of that is growth potential, we chose the price-to-earnings ratio as our other measure—the higher the number, the more the company's perceived growth potential factors into its market cap.

Defining tech

For starters, a couple of thoughts on companies we've chosen to leave out. One category that is extremely high-tech is the pharmaceutical industry. Either through in-house work or acquisitions, every major pharmaceutical company is now a biotech powerhouse, and relies on some really cutting edge approaches to generating products. Pharma companies are also huge. J&J, Roche, Pfizer, and Novartis are all within the top 30 (3 others are in the top 50), and would have made it onto our list, displacing more traditional tech companies.

Similarly, we're excluding telecommunications providers, even though some of them are equally huge. (China Mobile sits right behind Apple, AT&T is ahead of Google, and Telefonica and Vodafone are in the top-50). They both integrate lots of high-tech products and enable the latest and greatest tech toys, but progress here has been pretty evolutionary of late, and it's hard to escape the sense that they're simply offering pipes for others to send innovation through.

A couple of these are judgement calls. GE and Siemens, for example, would make the list, and definitely have a significant high-tech portfolio. But they're also massive conglomerates that make a lot of industrial equipment, so their market valuation is largely dependent on something other than tech. Samsung may have a significant presence in markets like home appliances, but it plays a major role in the tech world both as a chipmaker and as a seller of end-user products like hard drives, displays, and phones, so it made the cut.

So, who's left?

(All positions are taken from the Financial Times'list for the end of 2009. Market capitalization and P:E ratios were obtained on August 19th, and may not reflect the positions at the start of the year, or the date you're reading this. Currently, both values are relatively low for most stocks, due to recent volatility.)

Microsoft

Market cap: $212.27 billion, 4th overall; P:E of 11.7. The fact that Microsoft has stayed near the top of the heap for so long despite the fact that its stock price hasn't changed much in years is a testament to the staying power of its primary products: Windows and Office. Over the past several years, its Server and Tools group has joined Office and Windows as a steady contributor of profits for the company. These three divisions will ensure that Microsoft won't drop out of the top 10 anytime soon, and the pervasiveness of Microsoft's software means that it provides a backdrop for just about anything that happens in the technology world.

If the Office/Windows/Server trinity ensures that there will be no unpleasant surprises, though, the company has suffered from a dearth of pleasant ones in recent years, which has shifted it's P:E ratio well out of the growth range. The two areas that have shot Apple and Google into the top 10—portable consumer devices and Web services—remain thorns in Microsoft's side.

If those general outlines of the company's revenue are apparent to anyone who is paying attention, some of the specifics can be pretty difficult to figure out. Microsoft's internal organization often results in some odd pairings. For example, Entertainment and Devices includes the Xbox, Zune, and phone groups—but has also played host to the Macintosh software division. The group that registers Windows income, which is undoubtedly large, is saddled with Windows Live services, which will probably take a while before some substantial up-front development costs turn into a steady income stream for Microsoft's cloud services.

Those substantial caveats aside, as of the last financial quarter, the Windows and Business divisions are hugely profitable ($3.1 billion and $3.3 billion in income, respectively), while Server and Tools is pulling in nearly as much revenue, but costs a bit more to run—it produces a mere billion and a half in income from revenue that's only slightly lower than that of these other two divisions. Right now, those billions are floating the Online division, which continues to lose significant amounts of money, and the Entertainment and Devices group, which tends to bounce around being income-neutral.

Over the past few months, Microsoft has famously swapped places with number two on the list, Apple, although the situation remains fluid in the current, volatile market.

Apple

Market cap: $229.68 billion, 10th overall; P:E of 18.9. Anybody who has followed the company's history can remember times when adjectives like "beleaguered" and "insignificant" seemed permanently affixed to Apple. In terms of valuation, though, the company has now cracked the top 10 globally and is shooting towards the top. Although its valuation is typically ascribed to growth potential, the company's ability to keep adding profits through the recession means that it's now solidly in the middle of the pack when it comes to the P:E ratio of a typical tech company. And, as the company's earnings continue to climb, the ratio is actually dropping rapidly.

Even with those numbers, it seems that Apple's recent success has allowed it to have an impact beyond its numbers. We've reached the point where Apple can simply announce its intention to enter a market—take e-books, for a recent example—and trigger a complete reset. It's impossible to separate unreasonable expectations (on the part of everyone—consumers, press, competitors, etc.) from a realistic recognition of the company's marketing prowess and intensely focused management.

Apple tends to focus on unit sales of each of its major products—desktops, portables, iPods, iPads, and iPhones—but its 10-Q form contains a section with dollar figures on these (for its most recent quarter, it was on page 35). Desktops brought in $1.3 billion, laptops $3.1 billion, and iPods $1.5 billion. Two mind-blowing numbers: iPhones and related services were $5.3 billion, over a third of the company's revenue; and the iPad is already worth over $2 billion. Music products and services kicked in another $1.2 billion, and peripherals and software a few hundred million.

The actual income from each area isn't broken out, so it's difficult to know what to make of some of these figures. The company typically says that its music sales do a bit better than breaking even, but in a recent quarter, those were bringing in nearly the same sales that iPods themselves are. Apple has always used its software as a lure for hardware sales, but the relatively small sales figure suggest it could start giving all its software away for free tomorrow, and its bottom line would barely notice it.

IBM

Market cap: $162.14 billion, 17th overall; P:E of 12.1. IBM may have helped to fuel the personal computer revolution, but the number of IBM-branded PCs in existence is steadily shrinking as they retire. Although a major portion of its income comes through consulting now, the company has managed to stay relevant in a large number of areas of interest to the tech community through its open-source work, fabs, supercomputing efforts, and so on—its research labs make regular appearances in our science section, as well.

Although IBM is in some markets with a potential for growth, those are simply too small a portion of the company overall for anyone to consider it a growth stock.

In IBM's most recent quarter, it drew in $23.7 billion, good for an income of $3.4 billion. $5 billion of that came from software sales, like WebSphere and Tivoli; this group also had gross margins of nearly 90 percent. Hardware like mainframes and POWER systems supplied another $4 billion, but only had margins of 36 percent.

The conclusion that IBM is no longer a hardware company becomes more obvious when you start to consider the services divisions. Global Technology Services kicked in $9.2 billion in revenue and Global Business Services $4.5 billion. A large part of the company's earnings release is devoted to describing the amount of service contract income still outstanding, as well. None of this is to say that the company's hardware is completely unimportant. Some of IBM's software is run on its own hardware, and some of its service contracts are met using it. But it's certainly not essential, given that something like WebSphere also runs on Linux, Solaris, and Windows.

Google

Market cap: $150.80 billion, 26th overall; P:E of 20.6. Google has a P:E ratio that says growth, and it's not difficult to see why: two quarters ago, its year-over-year earnings growth was over 400 percent. Although the recession caused Google to cut back on some of the experimental projects that weren't working out, the company can still afford to keep things in beta for years without putting a dent in its overall growth.

To some extent, you might expect that Google's influence would be limited by the appeal of its cloud services. Lots of folks like online e-mail services, but a lot less enjoy editing a word processing document in a Web browser. But the company's tendency to integrate and aggregate means that events like its rollout of the Buzz social service, which inadvertently dragged in a lot of casual Gmail users, can have an overly large impact.

Right now, the company is in a somewhat unusual position, in that it doesn't entirely control what its next major move will be. Judge Denny Chin will get to decide whether Google becomes a book retailer and copyright clearinghouse or not, a decision that could have a very disruptive effect on a number of markets.

Until that happens, Google is likely to continue to be a one-trick pony, with over 95 percent of its revenue coming from advertising. That figure helps make sense out of some of the chaotic collection of services that the company is developing and testing: all of them either put ads in front of users or help Google to index information that enables them to target more relevant advertising. There's no doubt that Google would love to have sold more of its Nexus One hardware and more licenses to its cloud services, but, so far, it certainly hasn't had to.

Cisco Systems

Market cap: $126.61 billion, 34th overall; P:E of 16.8. When most people think of Cisco, they think of the high-end routers that help manage the traffic flows within and between large institutions. But, over the past several years, the company has been making strategic moves that indicate a desire to have access to the consumer market. It has purchased consumer networking company Linksys, the set-top box maker Scientific Atlanta, and is now making noises about wanting in on the hardware portion of the smart grid. In nearly every one of its markets, however, it's competing with a handful of companies that make substantially similar products, which is one reason that its announcements don't attract the attention of some of the companies in the same neighborhood, even when they've been excessively hyped.

Financially, it's been a steady money maker, and its cash reserves substantially outweigh its debt. Still, it's not paying a dividend, its P:E ratio has been on the high side until recently, and there are reasonable questions as to whether any of the markets it's currently in have the potential for sort of growth this ratio implies.

Cisco's 10-Q filing is infuriatingly vague about how it makes its cash. Over $1.7 billion from routers, another $3.6 billion from switches, and then everything else is dumped into Advanced Technologies ($2.4 billion) and Services ($1.9 billion). The advanced group is defined as including "application networking services, home networking, security, storage area networking, unified communications, video systems, and wireless technology." There's no effort made to define services or provide a glimpse into whether any of these segments are more or less profitable.

So about the only thing that can be said is that Cisco's attempts at diversification are generating some sales for the company, but it remains heavily reliant on its core businesses in the realm of high-end hardware.

I thought doing research is supposed to give good information. The information on this research is old. And some are wrong. Apple took over the number two spot and Ars still has a market cap value for apple of $180B, while MS has maintained their market cap of $270B. This is misleading. At the same time, as hhm said, IBM has higher PE than MS. Looks to me more editing is required before posting.

"Even with those numbers, it seems that Apple's recent success has allowed it to have an impact beyond its numbers. We've reached the point where Apple can simply announce its intention to enter a market—take e-books, for a recent example—and trigger a complete reset. "

Thank goodness for the antitrust actions against MS. Other innovative companies like Apple (see above) and Google would never have had a chance with that behemoth slinging its weight around. Handcuffing Bill Gates ambitions did the tech world a world of good, and didn't affect MS's earnings one bit.

Some of the data is out of date. The market caps etc people have already commented on, but note also that the MS division Entertainment & Devices doesn't exist any more. Robbie Bach and J Allard are out, Mac Office is now organized with Win Office, and the rest report directly to Ballmer for now.

I wonder if all the people pointing out the inaccuracies would have been as fast if the error were on Samsung and not MS? I notice all the points are associated with MS....hmmmm....

Anyway. My question is on MS also! You state that the ED&D has the Mac Business Unit. That is true, but reports have come out about it getting moved into the office division. However, I haven't found any information about timing. Maybe it was moved at the end of the FY? Does anyone have more info on the status of the MacBU and it being in ED&D or Office

The numbers on this article doesn't seem to be up-to-date, but that's okay since what's important is how large companies make money. However, I'm surprised that they have nearly zero information on Samsung. I don't think finding out what they do would be so difficult.

It seems what Financial Times was refering was Samsung Electronics, the largest company within the Samsung group, rather than the Samsung chaebol itself.

In summary, they sell approx. $8.5 billion of semiconductors (DRAM+Flash+ARM processors + HDD), $7 billion of LCD panels, $8 billion of cellphones, $8 billion of TVs, and another billion worth of whatever stuff per quarter, while having $4.5 billion of profit per quarter. (currently, $1 is around 1100 Korean wons.)

For anyone like me interested in Chaebol I found this quite interesting Especially that Samsung started of as a trucking company .

On the subject of the article:

Quote:

the iPad is already worth over $2 billion.

Holy Crap! I wondered what metric of success Apple would use for the iPad but that's an impressive number. I'd love to know what their R&D sunk costs were on the iPad because my understanding is that their margins on them are pretty good.

Is it possible that they tend to drive quite a bit of higher value app purchases (5 dollar games/apps rather than 1$ ones) Or does app sale revenue get allocated to a different bucket?.

It must have been that the P:E ratios were originally taken some time ago, then the article was written using those numbers, and then the P:E ratios were updated just before the story was released, so you find this:

IBM: "Financially, it has the lowest P:E ratio of anyone on our list"

IBM: 12.09Intel: 11.84HP: 11.68Microsoft: 11.6

Otherwise, good article. Interesting to see where the money's coming from.

Well, the whole article seems to be just a rough painting of the landscape. Not much substance.

In particular, lack of any tangible detail regarding Samsung is actually quite bizarre. I guess that's how a non-Korean views the company? It's huge, it makes technological products, and yet doesn't seem to exactly go out of its way to declare that it's innovating or what.

Well, the truth is, the company is very, very closely tied to the politics, sports, and economics of South Korea. The two cannot be viewed separately. Cities with Samsung factories, such as Suwon, are sometimes said to be part of 'Samsung Republic'. It's not just Samsung. The top 5 or so 'chaebols' have this sort of influence. Hyundai has Ulsan, where the company has a car factory (pumping out 2 million cars a year) and a huge shipyard. Not coincidentally, pro sports teams are run by these companies as well in these cities. For soccer, there's Suwon Samsung BlueWings and Ulsan Hyundai Tigers. There's also a baseball team owned by Samsung in Suwon. Basketball team in Ulsan is owned by Hyundai.

I should also note that both Suwon and Ulsan are metropolis with more than 1.1 million people living within the borders. Each.

This is precisely why the major chaebols in Korea never really disappears. It's also how the driving force of these companies are derived. You literally have an entire city to back you up. I'm telling you this as a person who was born and raised in Ulsan (dad worked for Hyundai) and now live in Suwon (the HDD factory is just over the hill). There's a very creepy aspect to this whole jig.

Did you know 80% of all cars sold in Korea are made by Hyundai (and Kia, but that's a Hyundai subsidiary, too)? Did you know that 60% of all cell phones are made by Samsung? Heck, back when I was a boy, I almost thought driving a non-Hyundai car in Ulsan would be a criminal offense.

The creepiness also permeates right into press and media. Obviously, chaebols are the biggest advertisers. They are not allowed by law to own a newspaper or TV station, but their influence is very tangible. News stories in Korea are quick to praise the virtues and excellency of Samsung Galaxy S, while simultaneously putting down the 'foreign foe', iPhone. The papers will scour around for sources to back the claims up, even if it's some obscure blog run by some dude. I've even seen intentional mistranslations and quotes out of context just to pull the feat off, in case the source sounds too neutral.

I'm fairly sure this is because iPhone is doing so well in Korea. It sold more than Samsung's flagship smartphone. That's got to hurt.

South Korea is hardly a small country in terms of economic prowess, but it's also a very compact nation. In a way, the chaebols like Samsung and Hyundai wring out the bloods of Koreans to make themselves tick. You might see them as just some big Asian tech companies. I see them as overlords. After all, when a company makes everything from hard disks to memory chips to apartment buildings to autonomous weapons (it's true!) to automobiles to ships, it's not like you can live a day without seeing that omnipresent logo.

A note for future articles of this type, please use enterprise value rather than market capitalization. The huge variance in debt levels of companies can have a big impact on EV while not being evident in market cap.

Oh, and I'm guessing that since this article lists Samsung, I should expect a newspaper article in Korea appearing soon about how Samsung is ranking right in top ten global tech companies and all that, citing this piece as the source. I've seen Ars articles getting referred before.

This list of companies is missing at least two important ones, Oracle. and Intel. The real innovation that has driven the business has been Moore's law. Each of these companies has built its business in different ways. But the ammount of real innovation is very limited and the real innovators are ususally different from those who wound up making money off the innovations.IBM clearly drove the business adoption of computer technology and the evolution of that technology for two or three decades. The basic ideas about software mostly come from a mixture of places like MIT, Stanford, IBM research, Bell labs, and Xerox Parc. The graphical user interface and the relational database are probably the most recent real innovations in computer software. Most of the rest is just struggling to actually implement ideas that have their roots in the 1960's.Basically, by the end of the 1980's, the unprecedented drastic change in the price/performance of computer technology created a number of different opportunities for expaded use of computer technology that IBM was not able to dominate. Although, they were not typically the first to market a particular technology, Microsoft was able to dominate the creation of client software for computer use in business environments. They also were able to establish a position as major competitors in the creation of server software for business computing enviroments. One factor in Microsoft's success has been a pattern of steady step by step enhancement of the funtionality of their software. For the most part competition with other software vendors has centered around the same basic software technologies. But Microsoft has been far more successful in actually developing software with those technologies that large numbers of people use.Oracle succeeded by building a very large business around relational database technology. It was a technology invented at IBM. Once Oracle had proved its value in the marketplace, IBM did manage to also become a substantial competitor. Microsoft has also been able to become a major competitor in this market.Cisco succeeded by dominating IP based networking. The development of IP technology was driven by the government and the academic world. A key objective with the technology was to be as simple as possible. There is some real innovation in the IETF based process that was used to develop IP. But the actual work of developing the technology was just standard engineering. The critical factor that enabled it was the drop in the cost of bandwidth that made a public data network economical. Of course the other big step was the combination of a markup language, hypertext, and a simple GUI based application that transformed the 3270 data stream into the web browser. Cisco was not responsible for any of this. It was just an aggressive company that was at the right place at the right time and more successful than its competitiors. I don't think Cisco even actually saw the public data network coming any better than anyone else did. Cisco was able to take over a business that IBM had dominated because it was more effective and because a large part of IBM's success was the result of selling a system of interdependent products. Once the network was public and outside the IBM data center, IBM lost a large part of its competitive position. It is also somewhat of a mystery to me how Cisco is making so much money. I think John's numbers are just for one quarter. The number that sticks in my mind is 40 billion dollars a year. By comparison the most IBM's networking division ever made was about 5 billion dollars a year and a substantial portion of that income was from mainframe host software.Apple's first phase was driven by being first, by appealing to a particular set of consumers, and by being particularly successful in adopting the Xerox Parc invention of a GUI. Apple's second phase has primarily been driven by Steve Job's success in taking over dominance of consumer electronics. If there are any major innovations that Apple actually created, they have escaped my attention. Although, I suppose it is reasonable to say that they were among the earliest to market a personal computer.Google has made its business by developing a new model for selling advertising. They have also been successful in marketing themselves has a technology leader for those who want to be hot..

So, because of the complaints, I've gone back and done Market Cap and P:E with today's values. Relative positions remain based on the year-end list from the Financial times. This article has been in the works for a while, and was interrupted by my trip to Germany and the LHC for science coverage, so some of the text had to be rewritten based on the fact that the recent stock market jitters reset many of the P:E ratios (nobody aside from Google really looks like a growth stock anymore). I got most of the text, but missed the bit about IBM. Mea culpa; it's gone.

You might see them as just some big Asian tech companies. I see them as overlords. After all, when a company makes everything from hard disks to memory chips to apartment buildings to autonomous weapons (it's true!) to automobiles to ships, it's not like you can live a day without seeing that omnipresent logo.

my wife is from seoul, and she had trouble trying to describe just how ingrained in the culture the chaebols had become. "well, they're really big" just wasn't cutting it. your explanation really helps describe just how pervasive they truly are.

If you think this, you don't know what their Business division does. Windows Phone 7 is unlikely to be a major player in MS's revenue stream, even if it's successful. It's likely to be a margin product for them no matter what.

Dynamics, SharePoint, and Office product lines are all on a convergent track in Microsoft, and all of them are being aggressively developed on. SharePoint 2010, Office 2010, CRM 2011, GP 2010 et al. are all designed to work tightly with each other in ways that are unique to the Microsoft stack. At the enterprise level, there is a lot of very interesting work and competition for that space that will keep any major player there from relying on inertia.

Well, the whole article seems to be just a rough painting of the landscape. Not much substance.

+++

This article is notable only for the lack of effort invested. It's quite pathetic, really.

First, there's the initial premise itself, which from the start is essentially thrown out the window by cherry picking broad swathes of tech companies to NOT include. Why not just change the premise to the gist of the article -- how 9 large companies we chose to examine make their nut? At least then you wouldn't have to try to pretend to objectivity and could cite market current market info across the board instead of cribbing from a 2009 table from the Financial Times yet using current P/Es.

Second, why even list P/Es? There was really no effort to compare P/E to the actual growth of the companies beyond vague handwaving about P/Es that say "growth" ? WTF is that? What is it about a P/E of 20 that says growth while a P/E of 18 doesn't? And if you really want some insight into Apple's P/E you should look at Andy Zack's excellent series of articles on Apple's valuation. His point that Apple's stock price growth is limited by the market's perception of it's capitalization and the subsequent P/E compression is spot on.

Lastly, all this article does is recap the latest quarterly results released by the companies in question, and badly at that. No real data was provided to allow us a glimpse into how these companies use their quarterly reports to obfuscate poorly performing products or divisions.

This was a bit of fluff masquerading as serious research, it would have been better presented as what it is -- a quick snapshot of nine tech company's financial status. No, make that eight companies. Samsung's results were notably lacking.

A note for future articles of this type, please use enterprise value rather than market capitalization. The huge variance in debt levels of companies can have a big impact on EV while not being evident in market cap.

And also, please explain the difference between the two for us noobs who don't always follow the financial jargon closely.

It concerns the value of outstanding shares and is not related to the capitalization of a given company. Yet, often I see "market cap" and "capitalization" used as if the two were synonymous, as in people discussing "market cap" as if it was "capitalization."

In particular, lack of any tangible detail regarding Samsung is actually quite bizarre. I guess that's how a non-Korean views the company? It's huge, it makes technological products, and yet doesn't seem to exactly go out of its way to declare that it's innovating or what. ..l. snip ...

Regardless of article content, I'm fairly certain that those companies wont appreciate you misusing their logos by re-branding them with the Ars Technica colors.

Yeah, but I appreciate it Thanks, Aurich, nice touch.

As to the content, yes it was rather slim for people who read tech news websites every day. Yes, the article does break down which divisions make what money (as far as SEC filings let anyone know), but this is often included in many tech news articles and there wasn't really a lot of analysis. Perhaps if a further focus was made on 5 (or fewer) of the 10, that might be more useful. e.g. a slightly wider look at Oracle and Qualcomm, what their current products are, what was different about them in the past and a little more on what the future might hold for them. Even a bit about their corporate hierarchy. Everyone knows of Larry Ellison and that he likes yachts, but who else is at the top, what influence do they have, how long might they remain there and who might succeed them? Perhaps a whole article on the CTOs of the big players...

You might see them as just some big Asian tech companies. I see them as overlords. After all, when a company makes everything from hard disks to memory chips to apartment buildings to autonomous weapons (it's true!) to automobiles to ships, it's not like you can live a day without seeing that omnipresent logo.

my wife is from seoul, and she had trouble trying to describe just how ingrained in the culture the chaebols had become. "well, they're really big" just wasn't cutting it. your explanation really helps describe just how pervasive they truly are.

It lends new meaning to the phrase "company town". In some dystopia future were corporate nations rule, the Samsung logo may be prominent, right up there with Taco Bell.

As long as all of the same color ( Ars Orange ) they will not make a fuss about it. as long as they are not using it to promote/Sell and it is in good faith ( they are comparing the companies ) it should be fine. the color change is no different than making it all B&W. most will not even bat a eye

I agree that I would like to see a "spin-off" article from this one about the economic life of Korea. Another "spin-off" I would be curious about is an article explaining how Google is now perceived as such a "player" in Microsoft and Apple's areas (OS, software, hardware) when 95 percent of their revenue comes from... advertising!